The FINANCIAL — On July 6, 2016, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Italy.
The Italian economy is recovering gradually from a deep and protracted recession. Buoyed by exceptionally accommodative monetary policy, favorable commodity prices, supportive fiscal policy, and improved confidence on the back of the authorities’ wide-ranging reform efforts, the economy grew by 0.8 percent in 2015 and continued to expand in the first quarter of 2016. Labor market conditions have been improving gradually, and nonperforming loans (NPLs) appear to be stabilizing at around 18 percent of total loans. Nonetheless, the structural challenges remain significant. Productivity and investment growth are low; the unemployment rate remains above 11 percent, with considerably higher levels in some regions and among the youth; bank balance sheets are strained by very high NPLs and lengthy judicial processes; and public debt has edged up to close to 133 percent of GDP, a level that limits the fiscal space to respond to shocks, according to IMF.
Against this backdrop, the recovery is likely to be prolonged and subject to risks. Growth is projected to remain just under 1 percent this year and about 1 percent in 2017. Risks are tilted to the downside, including from financial market volatility, the refugee surge, and headwinds from the slowdown in global trade. This growth path would imply a return to pre-crisis (2007) output levels only by the mid-2020s and a widening of Italy’s income gap with the faster growing euro area average. It also implies a protracted period of balance sheet repair, and thus of vulnerability.
Cognizant of Italy’s complex challenges, the authorities have embarked on a range of very important reforms, including institutional, public administration, fiscal, labor market, and banking sector reforms. It is imperative that these efforts are fully carried out and deepened. Taking advantage of the start of economic recovery and the current favorable tailwinds of monetary easing, low commodity prices and fiscal support, the timely implementation of complementary and mutually reinforcing efforts in the financial and fiscal sectors and structural measures would help boost growth, lower the upfront cost of reforms, and accelerate the building of buffers.
Executive Board Assessment
Executive Directors noted that Italy is recovering from a protracted recession supported by accommodative monetary and fiscal policy, favorable commodity prices, and improved confidence on the back of the authorities’ wide-ranging reform efforts. Nonetheless, Directors noted that the recovery is likely to be modest against the backdrop of an unsettled external environment, structural rigidities, strained bank balance sheets, and high public debt. They, therefore, urged the authorities to fully implement and deepen the reforms to strengthen near-term growth, further build up buffers, enhance resilience, and bolster economic performance over the medium term.
Directors welcomed the implementation of the Jobs Act and the approval of a framework law on public administration reform. They noted the high youth unemployment and low female labor participation, and supported implementation of active labor market policies. They called for pressing ahead with ambitious product and service market reforms, including a strengthened Annual Competition Law; modernizing the wage bargaining system to align wages with productivity at the firm level; and implementing public administration reforms decisively, including to lower the cost of doing business and improve the investment climate.
Directors underscored that financial sector reforms are critical to entrench financial stability and support the recovery. They commended the recent insolvency reforms, the framework for bank consolidation, and steps to address nonperforming loans (NPLs). To substantially reduce the stock of NPLs over the medium term, lower the cost of risk, and improve operating efficiency, Directors supported further measures, including more intensive use of out-of-court debt restructuring mechanisms; strengthened supervision; and a systematic assessment of asset quality for banks not already subject to the ECB comprehensive assessment, with follow-up actions in line with regulatory requirements. Directors considered that effective use of the framework for the prompt resolution of banks is important. Recognizing the adoption of the Bank Recovery and Resolution Directive (BRRD) framework, they noted that concerns related to the bail-in of retail investors should be dealt with appropriately.
Highlighting the need to balance efforts to reduce debt with support for growth, Directors noted that the debt dynamics are expected to decline only gradually in the coming years and remain vulnerable to shocks. Building on the progress achieved recently, they urged the authorities to move forward decisively on pro-growth reforms, giving greater priority to lower and more efficient spending and less distortive taxation, including broadening the tax base and introducing a modern real estate tax. Many Directors saw the need to place debt on a firmer downward path as a priority to enhance resilience to shocks, and accordingly recommended an evenly-phased adjustment over 2017–19, net of any remaining upfront costs from structural reforms, to achieve a small structural surplus. A number of other Directors, however, saw merit in backloading adjustment to cushion the impact on growth, while considering a balanced budget as an appropriate medium-term objective, but called for special attention to managing risks, including through ambitious privatization efforts.